Deciding Whether to Pay Off Debt or Invest

How to spend your money is a question for the ages. Each person has to weigh their wants and needs in the here and now against the potential for future earnings when deciding how to allocate the funds that they currently have in hand. Some people choose to purchase homes, which are useful in the immediate sense and likely also as an investment in the future. Others go to college, which also serves as a potential investment (as long as you don’t major in botany, for example). But once you’re out there earning money, you’ll eventually come to a point where you have a little extra on hand. So should you use it to pay down your current debt (in order to lower the amount of interest you pay in the long run) or invest it in retirement accounts as a way to plan for your far-off future? Here are a few tips to help you decide.

In reality, it comes down to two major considerations: how much do you stand to save by paying down debt and how much do you stand to earn by investing in retirement options? And these numbers will fluctuate with time so you might want to revisit this debate frequently. But let’s start by discussing what you could gain from each option.

When it comes to paying down debt, there is a decided advantage to putting extra money towards the principle on your loans each month; the faster you pay off the initial loan, the less you’ll pay in interest. Sounds pretty simple, right? It can be, so long as you read and understand the fine print on your loan agreement. Some come with penalties for early repayment, so make sure you won’t end up paying just as much in fees as you saved in interest.As for retirement accounts, there are several benefits to be gained, the biggest of which is compound interest. What this means is that any money you put in earns interest. Then the interest accrued in the account starts to earn interest as well, growing your nest egg much faster than an average savings account (and at a higher interest rate, to boot). In addition, any funds contributed to a 401K, Roth IRA, or other retirement account are considered pre-taxable income (up to a certain amount each year), so this money will either be taken from your pay check before taxes (if your employer manages your 401K) or you can list it as a deduction on your tax forms. As a bonus, many businesses match your contributions up to a certain percentage of your gross pay (usually around 5%). These considerations could make this option far more desirable than paying down debt, especially considering that starting early is imperative.

Of course, you could also consider a portfolio of stocks, bonds, mutual funds, and so on. Rising stocks (such as gold bullion, green technologies, and 3D printing stocks, for example) have the potential to earn you more than 10% annually if you invest wisely, and this is a lot more than any other option. The downside is that they are equally likely to tank, causing you to lose everything. So when it comes to investing versus paying down debt, you’ll simply have to weigh your options, check the numbers, and decide how much you want to gamble. The outcome depends almost entirely on the individual.